The elasticity of demand for foreign exchange and the exchange rate of the Naira

Abstract

This article examined whether devaluation is a more effective and simpler policy measure for reducing the level of imports or pressure on the foreign exchange budget in the Nigerian economy. In other words, would devaluation represent an effective and efficient alternative to the present maze of ad hoc trade and exchange regulations? The answer to this question is dependent largely on the elasticity of demand for foreign exchange in the Nigerian economy. Foreign exchange elasticity means the relative responsiveness of the amount of a foreign currency (e.g. U.S. dollar) demanded, as a result of exogenous changes (devaluation/ revaluation), in the units of another currency (e.g. the naira). In other words, the term "elasticity" basically measures the percentage change in some other variable(s). Thus the demand for foreign exchange in the Nigerian economy would be considered price elastic if the percentage decline in the amount of foreign exchange demanded is greater than one in response to a I per cent rise (depreciation) in the exchange rate of the naira. It is price inelastic if the percentage decline in the amount of foreign exchange demanded is less than one in response to a 1 per cent rise in the exchange rate of the naira.